FARMINGTON HILLS, Mich. (ResourceInvestor.com) -- Today I'll first tell you the official reasons, stated by a leader of the platinum group metal (PGM) trading community, for the dramatic decline in the price of rhodium. It began, and is now very much accelerating, during 3Q2008. I will then tell you a tale, which contradicts those "official reasons" for the price decline. This is a story that is making the rounds in the Detroit OEM automotive community, certainly the location of, collectively and individually, some of the world's largest end users, and therefore 'buyers' of PGMs: General Motors Corp., Ford Motor Co., and Chrysler Group LLC. Finally I will give you my opinion both of the veracity and of the credibility of each of the conflicting "stories" and, at that point, let you decide where the truth lies.
I have written about the rhodium market here several times during the last few years, and I want to repeat again to you my admonition: Buying and selling rhodium for speculation is only for those who can afford to lose large sums of money rapidly. It is a game best played with insider information-not illegal insider information but rather intimate knowledge of the end-user and supply markets-and shouldn't be undertaken by anyone who doesn't have a critical need for physical rhodium, i.e. for an industrial process. There is no 'play' in rhodium for the small investor; and I mean to include in the 'no play' category any recycling 'schemes' not directly involving an end user guarantor of scrap supply and of purchase of last resort. Am I clear?
First, some background on rhodium fundamentals:
The rhodium market is very small, and populated by very few well-known producers and a somewhat greater, though still very small number, of large (compared to the total size of the supply) end users. Those end users consume all of the new rhodium produced and absorb, most of the rhodium recovered by recycling of their own scrap. Some 80% of annual new production of rhodium, a platinum mining byproduct, comes from southern Africa. It recently has been driven up to nearly 825,000 troy ounces a year.
Rhodium has a few, but very important, chemical uses:
- Production of non-reactive (with glass) mostly rhodium-alloy crucibles, and extrusion appliances, called spinnerets, for the fiber glass necessary for fiber optics; and
- The key ingredient of the catalyst used to produce nitric acid, a very important chemical commodity.
Rhodium required for both of those purposes is normally recycled by its original consumer over and over again in the chemical and glass industries. Only an expansion of facilities or the construction of new ones requires the chemical or glass industry to buy 'new, additional' rhodium supplies.
Rhodium's use, though not the actual volumes used, in the OEM automotive industry is even more limited. It catalyzes the reduction of the acid-forming nitrogen oxides (NOx)-from internal-combustion engines' exhaust emissions-back to harmless nitrogen. This last use is critical for vehicles makers in all but a dwindling number of countries. This because almost all nations now prohibit the production or sale of vehicles powered by internal combustion engines unless they are fitted with a catalytic converter to assure complete combustion of unburned hydrocarbons and carbon monoxide. Simultaneously it ensures the reduction of NOx formed during the combustion process back to elemental nitrogen. For this last function, only rhodium is economically effective.
The global OEM automotive industry, by far, is the largest user of rhodium. It's been estimated that as much as 85% of the annual rhodium supply-both from new mine production and from recycling of spent auto catalyst-goes into the production of automotive exhaust-control catalytic converters. In 2007 this would have amounted to some 850,000 ounces of the 1,000,000 ounces of rhodium mined and recovered from recycling for that year.
At this point 2007's total global production of surface-road vehicles was 85 million units. On May 21, 2008, Purchasing.com published the following story: Johnson Matthey: Rhodium demand is exceeding supply. On August 20, 2008, Purchasing.com published this article: Rhodium price plunges to 8-month low--precious metal drops 50% since June.
The chart below shows rhodium prices for the year ending August 20, 2008:
You are now have the official statements on the 60% drop in rhodium's price between 'mid-June 2008 and August 20, 2008, a period of slightly more than 60 days. This from both the world's best-known rhodium price-reporter (Platt's), and from the world's largest rhodium trading company.
As I understand it there was a deficit 'scenario' projected for the rest of 2008 as there was supposed to have already been for 2007. This would have meant that, on June 21, 2008, the price of rhodium could have been expected to continue to rise. This was mainly due to OEM automotive industry consumption exceeding production and recycling. Moreover production would be impacted negatively by South African mining 'woes.' There was really only a single woe at the time: the supposed reduction of electric power being supplied to the PGM mining industry in the Republic of South Africa (RSA). This was due to the power shortage there diverting electricity supplies to consumer rather than industrial uses. This, of course, turned to be inaccurate. It turned out, as I have written here before, that the RSA's government allowed almost full power to those industries that garnered the most export-sourced foreign exchange earnings per kilowatt. This meant platinum, rhodium, and palladium producers kept their electric-arc furnaces going while the ferroalloy furnaces went cold.
By August 20, 2008, when prices for rhodium (and platinum, but that is another story) were in free fall, there was little production shortfall caused by South African woes. Nonetheless the understatement was issued by Platt's (above) that, "trade sources [are] saying there have been more sellers than buyers lately." Ya think?
Why? It certainly wasn't due to the reduction of annualized production of new cars in North America as many, many experts are claiming. Even if the worst nightmares of GM, Ford, and Chrysler come true and North American car production declines from a projected 16.5 million to 12.5 million for 2008, this will take only 4 million cars out of the global market. This will amount to 5% of global production. Wouldn't it be logical then for rhodium prices to stabilize-if the metal's supply were, prior to this slow down, in 'slight deficit' as Platt's and Johnson-Matthey implied? In the worst case perhaps the price might decline by 5% on an actual demand basis. So what happened?
Let me tell you what people in the end-user sector in my home town, Detroit, are saying. It is being said here that the global crash of the price of rhodium is due to the foolish and unskilled actions of a single employee of the purchasing or finance staff of a once-great American OEM automotive end-user of PGMs. That once great company, it is said-until fairly recently-had the most skilled strategists in the global OEM automotive industry in its purchasing group. Their expertise on the insurance of the risk of price and availability of the PGMs was applied by car makers on their exhaust emission control systems.
For unknown reasons this skilled group was dissolved, even though it's believed to have had an unbroken record of success at doing its job. Some say this was internal jealousy of the company's finance staff. It supposedly didn't like purchasing people doing what it considered to be 'finance staff' work. Others say that it was just ignorance on the part of the company's top managers who didn't understand the importance of hedging or of the futures market other than for trading currency.
It may have been simply that the formerly great company just lost its edge through retirements, and the discovery that hiring outsiders to continue the work would have required salaries, which in the OEM automotive world, are reserved only for those at the very top.
In any case, regarding rhodium, what is said to have happened is:
- Retirement musical chairs. The manager in charge of procuring PGMs-until a couple of weeks ago-was the second or third man to hold the position in just the three years since the long term and very skilled in PGM trading and hedging holder of that assignment was 'retired' after an internal dispute with top management about what he considered counter-productive constraints on responsibility creating unfair liabilities for himself and his staff.
- Sell & buy back. Shortly thereafter, it's said, his first successor-who had no prior experience in the PGM markets, sold off the company's physical rhodium inventory. This since he saw that it had a low cost-basis on the company's books, and it was then selling at a substantial multiple of that basis. It was also the end of the calendar year, so that he was able to deliver a nice number to the company's bottom line and be regarded as a hero for that alone. In his total ignorance of the market for rhodium, he assumed that since its price had at that time been flat for a while it would remain flat-and he could buy back just what he needed, around 5,000 ounces a month as he needed it. Since no good deed goes unpunished, it of course happened that rhodium began rising at that time and the feckless seller had to buy material on the market at an average of $2,000 per ounce more than he had sold it for. Thus cash flow for rhodium increased immediately in the next calendar year by $10 million a month and rose from there.
Now we come to our present situation and story. It's now two years later and the successor to the man who sold the rhodium when he shouldn't have it is said now decided not to repeat that mistake. So he came up with a new blunder. He decided to stockpile not six-months worth of rhodium as the formerly great corporation had been doing but 18 months worth, and he proceeded to do just that. This meant that the formerly great company wound up holding or controlling by the end of the spring 2008, some 10% of the global rhodium supply. On June 15, 2008 this inventory had a nominal value of nearly $1 billion dollars. The top financial managers of the great corporation announced that they had made a huge amount of money in futures trading even though the formerly great corporation had its worst overall quarter ever in early 2008. Perhaps the top managers even believed that since the rhodium (and platinum) inventory was now priced at all time highs for both metals they actually had 'made money.' The problem was that they needed liquidity, so it is said they instructed the hapless PGM buyer to correct his inventory to the previous standard of six months physical. He then actually went to the RSA to see if agreements could be cashed out, or unwound, or sold to another buyer with profits for both the producer and the formerly great company, or changed. The producers wouldn't do anything but stick to the original terms.
So what would you think would be the worst thing one could do in this situation? You are right. It would be to try and sell a large amount of rhodium into a declining market. The hapless, unsophisticated, unskilled-in-PGM-trading manager, it is said, offered 30,000-60,000 ounces of his 90,000 ounce rhodium inventory to the market. So he not only corrected the slight global market deficit, but also sent the market into instant surplus. The market collapsed; and the manager was transferred to another country and another job. Rather than having a rhodium inventory marked to market at $1 billion the formerly great company now has a remaining inventory it is said worth at market a maximum of $240 million. We are waiting for the announcement of the nearly $700 million loss, but I don't think we will see it anytime soon. Perhaps it really never happened.
By the way I heard that the same situation occurred with the formerly great company's platinum inventory, but that inventory only lost a third of its value in the exact same time period for the same reasons.
This is a cautionary tale for small investors. If you think that someone has worked out a way for the little guy to make a play in a rare thinly traded minor metal such as rhodium please keep in mind that there is a credible story that a Fortune 500 end user of rhodium crashed and burned. This by convincing itself that trading one commodity is just like trading another so that any member of the finance staff is up to the job managed to lose as much as a billion dollars of the shareholder's money because he and his management were way over their heads. An analogous situation actually is well known to have occurred in 2001-2 when panicked and inexperienced buyers at Ford and Toyota convinced by sophisticated advisors from a New York-based financial institution that palladium was going to go to $3,000 an ounce entered into take-or-pay agreements for several years forward that obligated them to pay $500-700 an ounce for palladium that never again went over $300 an ounce during the lives of their agreements. Those deals cost Ford and Toyota each over $1 billion in write downs.
Do I believe that the events I described above as occurring at a formerly great cooperation actually happened? Ockham's razor is the principle that if you have to choose between two explanations always choose the simpler one. I believe that:
- It is entirely likely that a single seller of a large amount of rhodium set off the great decline in the rhodium market of the summer of 2008; and since it is not possible to produce rhodium without producing platinum
- The same seller also was disposing of excess platinum he had agreed to take so that the original producer/seller's inventories would remain matched.
Do not at this point in time invest, please, in either rhodium or platinum, until this all shakes out.
If one of the OEM American automobile manufacturers, by the way, should go bankrupt and cease production then that company's inventory and lack of future need for PGMs could knock the bottom out of the market immediately. Be very careful from now on, because some of New York's finest financial-advisors are telling their clients that the American OEM automotive industry is more than likely to go bankrupt before 2012.